The pressing need to root out corruption

The rubbish heaps in the centre of Naples and the ever-larger bailouts of debt-ridden eurozone countries are two aspects of the same issue — corruption. The most debt-ridden euro nations also are the most corrupt. Their ruling politicians are fighting the crisis with austerity. Public anger in the debt-ridden euro countries stems not just from the hatred of fiscal cuts but also the grotesque injustice caused by the rampant corruption apparent to anyone living in the worst hit euro countries.

In the grand macro-economic scheme of things it is easy enough to explain the European debt crisis: a) the fallacy of banks and other lenders pricing the risk for all eurozone countries, from Greece to Germany, as the same; b) the insatiable hunger for cheap money, both in the private and public sectors, by emerging markets on the European periphery; c) for every greedy borrower there is an even greedier lender willing to supply cheap money; d) countries with insufficiently supervised banks, exposed as undercapitalised and stuffed with bad loans, are taking on debt to recapitalise private banks; e) insufficient write-down of public and private debt; f) inadequate bankruptcy regulation.

But this standard description overlooks the fact that in each of these countries corrupt mechanisms are a leading cause of unsustainable debt. Corrupt practices differ in different countries but the result is the same.

Ireland

Around Ireland, empty houses stand as a monument to this corruption. They were built not out of demand for more housing but as part of a mechanism that channelled money to parties in the building racket.

The Celtic Tiger was born of the rapid growth of the mid 1990s. Strengthened by the euro, it was driven by an abundance of cheap money flowing into the construction industry. Property development was dependent on local politicians and planning authorities, enjoying the political patronage of Fianna Fáil, in government from 1987-2011. The building boom filled brown envelopes passed around when politicians and businessmen mingled at the Galway races. The Mahon report, published earlier this year, uncovers this relationship, albeit only during the 1980s and the 1990s. Prime Minister Bertie Ahern was forced to resign in 2008 after corruption allegations: among other things, he was supposed to have bought a flat with money he could not account for. He is not being investigated.

In September 2008 the Irish banking system was teetering on the brink of collapse. The Irish government announced it would guarantee the banks, no matter what, for two years. Later, the European Central Bank, fearing the euro would be undermined by bank defaults in the euro zone, pressured the Irish government into recapitalising its banking sector. In spite of rumours of foul play the banks were not investigated. In November 2010, the Irish government asked for a bailout of €85bn. Irish government debt rose from 25% to GDP in 2007 — well under the Maastricht criteria of 60% — to 107% last year, and the debt level continues to rise. So started the eurozone path of burdening the state with private debt.

Greece and Cyprus

Greeks consider their country the most corrupt in the EU. Even a short stint in government could make ministers financially secure for life. The public sector became ever more bloated. Cash payments eased contacts between parents and teachers, patients and physicians. Tax evasion was the norm, and tax collection inefficient. Property taxes could not be collected since there was no comprehensive property registry.

Sheltered by euro membership and low interest rates, the Greek state went on a borrowing spree. Already in 2003, Goldman Sachs famously helped hide Greek debt, collecting at least €500m in fees from a €2.8bn swap transaction with the Greek government. By the mid 2000, the Greek economy was growing fast, but so was its structural deficit.

A thrilling chapter of the Greek debt saga happened at Elstat, the Greek office of national statistics. As the debt crisis exploded in 2009, it transpired that the real debt was much higher than the available data showed. This surprised many but not Eurostat where Greek data had long been viewed sceptically. An ensuing feud at Elstat reached its climax when the director was accused of treason for publishing the correct numbers.

Corrupt waste of cheap funds eventually brought down the financial system and the debt migrated to the already indebted state. In early 2010, Greece secured loans of €52bn, a bailout of €110bn in May the same year and then another bailout of €130bn in summer 2011, steered by the now familiar troika of EU, the ECB and the IMF. The only national default in Europe so far happened in Greece early this year with a write-off of 53.5% of its nominal private debt as lenders added a second bailout of another €130bn. Public debt is now around 160% to GDP, the highest in the eurozone. With a prolonged recession in sight, further loans and/or restructuring seem likely.

Cyprus, a euro member since 2008 and heavily exposed to Greek bank debt, was badly hit by the Greek financial meltdown though its public debt of 72% to GDP is not alarming compared to other troubled countries. But Cyprus has a friend no other euro nation has. As the favoured conduit for Russian oligarchs’ money on their way into the EU (which says a lot about Cyprus), the Kremlin issued an emergency loan of €2.5bn to Nicosia this January. But it was not sufficient: further Russian loans are not forthcoming and a bailout is now being discussed with the troika, apparently €6bn for a state bailout and €5bn to recapitalise the banking system though Cyprus has only been a member of the euro since 2008.

Spain and Portugal

Castellón airport in eastern Spain was due to open last year but is now a ghost airport with an uncertain future. The Ciuadad Real airport near Madrid was in use for just three years before it closed due to insufficient traffic. The two airports are the most spectacular Spanish memorials of corruption and waste.

After receiving up to €100bn in June to refinance the banking sector Spain is now trying to secure a seemingly unavoidable bailout without suffering the Irish fate of the state taking on the banking debt. Like Ireland, Spain has had reasonable debt levels — 90% to GDP in 2011 but rising. Showing good results in 2008 and 2009 the Spanish banks looked like paragons of restraint but their results are now attributed to clever accounting, which hid losses, making it all more costly in the end.

The Spanish debt saga is similar to the Irish one: at its core are corrupt relationships between local politicians, regional cajas (saving banks, like the German Sparkassen) and the construction industry, along with European structural funds. Bankia was formed in 2010 by merging the worst cajas, avoiding write-downs. The cajas’ loyal clients were encouraged to help their country by buying Bankia shares, now worth very little. Together with more than thirty Bankia managers, Rodrigo Rato, the Partito Popolare politician and former chairman of Bankia, is now under investigation.

The Portuguese debt saga is less well known abroad than the Spanish and Greek ones, but it is similarly rooted in four decades of inefficient and corrupt political meddling, with the usual outsized public sector in a corrupt country. European structural funds financed mismanaged public projects. The credit crunch exposed structural problems and public debt. Early in 2011, Portugal received a bailout of €78bn. Public debt is 107% to GDP and rising but so far Portugal is deemed by the troika to be on the right track.

Italy

The graves of judges who came too close to corrupt politicians, and an unused EU funded incinerator close to Naples, stand as memorials to Italian corruption.

Though struggling with refinancing, Italy runs a prudent deficit similar to that of Germany though Italian debt is 120% to GDP. High public debt is nothing new in Italy where most of the debt is held with domestic lenders, from banks to pensioners. Its economy is fairly robust and Italy might muddle through — and yet Italian ‘malavita’, or mafia activity, is the stuff of myths and movies.

The infamous rubbish collection in Naples is one manifestation of the corruption that thrives on public-private partnerships, now possibly a more important source of income for organised crime than drugs and human trafficking. Corruption cases that surfaced in the early 1990s caused the collapse of the political order dominated by the Christian Democrats and paved the way for Silvio Berlusconi’s rise to power. Now, another wave of political corruption cases is shaking Italian politics and might well cause a similar shakeup.

Corruption grows where the state is absent

Giovanni Falcone, the Italian judge murdered by the Mafia in 1992, once wrote that the Mafia is where the state isn’t. That counts for any kind of corruption; it thrives in spaces left without policing and other public supervision.

The debt-ridden euro countries all leave much space for corruption. They are plagued by inefficient public sectors, overstaffed by people given jobs through patronage regardless of merits. Public projects, often funded by the EU, have been mismanaged and become black holes into which enormous sums have been sunk. Corruption kills competition and hinders new business opportunities. Tax evasion is endemic and demonstrates a lack of concern for the public good. In general, people are not aware of how corruption undermines civil society.

In an article in the Financial Times in June 2011, Mario Monti, now prime minister of Italy, wrote that “the past indiscipline of specific (EU) member states ... could simply not have occurred without two widespread failings by ... the European Council: an unhealthy politeness towards each other, and excessive deference to large member states.”

Monti does not single out corruption but points out how France and Germany blocked giving power to Eurostat to investigate statistics provided by member states. Monti also pointed out how the credibility of the stability pact was “severely impaired” in 2003 when Ecofin decided against issuing warnings to France and Germany for breaking the pact, though such warnings had been given the year before to Ireland and Portugal.

The EU has shown the same unhealthy politeness and excessive deference to corrupt practices in countries that for decades have received funds from the EU structural funds and have now received, or might receive, a bailout. When mature and fairly stable economies like France, Germany, the Netherlands and Finland tied their economic fortune and destiny to the countries on the periphery, they did so without properly considering the destructive effect of corruption. We now know better. So far this has cost European taxpayers almost €700bn, and no doubt there is more to come.

The crisis lays bare that endemic corruption is a costly state of affairs. Sadly, it went from bad to worse when, instead of writing off debt right when the problems surfaced in 2007 and 2008, the corruption was propagated by nationalised losses, after the profits had been lining corrupt pockets for years.

Interestingly, the worst hit euro countries score highest on the Eurobarometer for nations that see themselves as corrupt: 1 Greece (98%), 2 Portugal and Cyprus (97%), 3 Slovenia (95%), 4 Spain and Malta (88%), 5 Italy (87%), 6 Ireland (86%). It comes as no surprise that Slovenia is now about to ask for a bailout.

Painful austerity is the preferred solution to corruptly accrued debt. But ask the citizens in these countries if they think the politicians are doing enough to fight corrupt practices that led them into their current predicament and the answer is a resounding No! Social unrest and public anger in these countries are not just responses to cuts in public services. It is a response to politicians who are making cuts in the wrong places. They are all too happy to cut pensions, wages, hospital funding, education) while failing prosecute the culpable and eradicating the underlying problem, corruption.